If this The Economist article is correct, then either the valuations of online advertising platforms (like Facebook and Google) or traditional offline platforms (like TV stations), or both are too high.

Online Advertisers’ Increase in Market Capitalisation

The online advertising world is becoming increasingly dominated by a dozen US companies, whose market capitalisation has increased by 126% over the last 5 years, to $2.1trn. The largest of the companies are Alphabet (which owns Google, and 88% of whose sales comes from ads) and Facebook (97% of whose sales come from ads) – together their share of the digital ad market in the US has increased from 45% in 2011 to 63% in 2017 (84% on a global basis, excluding China).

TV Broadcasters not to lose ad revenue?

Are the increased online ads coming at the expense of offline ads? It seems not, as implicit in the valuation of large TV broadcasters in the US is that their ad revenues don’t fall by a lot.

Valuations Imply Ad Spending Increases to 1.8% of GDP

In The Economist article, it’s estimated that the market valuations are implying US advertising expenditure will increase from its historic (since 1980) average of 1.3% to 1.8% of GDP in 2027 (today it is 1% of GDP).

An argument why advertising may increase is that historically smaller firms haven’t spent as much on advertising, as they are going to in the future because of:

its ease of use (Rob: but surely we should see some of that coming through in the numbers already?).

the ability to target advertising to carefully defined groups.

But there are 2 boundaries that the size of advertising should struggle to cross:

Advertising costs should not be able to increase by so much that their return on capital falls below their cost of capital. As The Economist puts it: “Imagine if advertising spending really did rise to 1.8% of GDP in America by 2027. Most firms costs would have to rise, cutting total corporate profits (excluding those of ad platforms) from about 6.5% to 5.7% of GDP, the kind of drop normally associated with a recession. Alternatively, imagine if the firms in the S&P500 index (excluding ad platforms) bore all the additional cost of the advertising boom. Their combined ROC would drop from the present 10% to 8%, at or just below their cost of capital. America inc would go from being the world’s greatest profit machine to flirting with Japanese-style financial-zombie status.” (Rob: it isn’t realistic to attribute all the additional advertising costs only to S&P500 companies, as companies worldwide are contributing to the increased advertising spend).

There is only so much advertising which consumers can absorb before becoming too irritated by the platform. This is seen in the popularity of ad free platforms such as Netflix and Apple.

Implicit in The Economist conclusion is that market valuations possibly:

Are too high for the online ad platform firms; and ad sales wont grow at “compound annual rates of 15% to 20% for a decade, as their valuations imply”.

Conventional media firms will see their ad sales dropping fast rather than stagnating (meaning their valuations are too high)

Rob 1: The other possibility/probability is that non-US traditional media firms will see a reduction in their conventional (TV, newspapers,…) advertising revenue, with it switching to US online ad platform companies. For example Naspers’s South African businesses; although the valuation of that has already been hammered. This feels like a more likely than not scenario.

Rob 2: We may see an increase in the concentration of companies enjoying the spoils of online advertising revenue spend.

Rob 3: Warren Buffett was probably on safer tech territory investing in Apple, which isn’t as reliant on online advertising revenue as Facebook and Google. (Disclosure: I own Apple; note: Apple has risen some 70% since the low point at which Berkshire was buying, so not as attractive to buy now as it was then).

Other Online Advertisers

In the 4th quarter of 2017 Twitter turned a profit for the first time. The share price of Snapchat recently increased by 48% on higher revenue. However, Twitter & Snapchat are FAR smaller than Facebook and Google in terms of online ad revenue.